The restaurant industry is a booming sector in the US. It’s estimated to have brought in $899 billion in revenues during 2020 alone. About 99% of establishments of this industry are privately-owned, making it the country’s second-largest private employer. As per a recent survey by the National Restaurant Association, the restaurant industry employed over 15.6 million people and is set to create over 1.6 million new jobs between 2020 and 2030. But not all restaurant stocks are alike. In this article, we’ll discuss 11 key items that investors should look for, before investing in restaurant stocks. We’ll also the risk factors and red flags that you should look out for, while investing in the industry. Let’s get started!
There are some terms and metrics of the restaurant industry that an investor should have an eye out for:
- System sales– Restaurant companies have a few different operating structures. These include having company-owned stores, franchised stores or a mix of both. So, there’s a term called “system sales” which refers to the combined sales across all the operating outlets, be it company-owned or franchised stores. Tracking system sales helps in understanding how the entire restaurant chain (company owned and franchised stores) is performing as a whole. If system sales are suffering, then it raises doubts on whether the brand is losing its relevance or competitive positioning in the market. Conversely, consistently growth in system sales indicates all involved stakeholders — the company and its franchise network — are thriving due to a mix of good capital allocation, brand positioning and store additions.
- Revenue – The revenue figure in the restaurant industry is slightly different from the aforementioned system sales. A restaurant chain’s revenue is the aggregate franchising fee that it earned from its franchises, in addition to the revenue that it earned from from its own company-owned stores. In this calculation, we leave out the revenue earned by its franchises.
- Comparable sales – Restaurants chains grow revenue by opening new stores and by expanding sales of their existing stores. The comparable sales figure tracks the latter — it encompasses sales from stores that already existed a year ago and doesn’t include the revenue contribution from new stores. This reflects an accurate picture of the restaurant chain, since newly opened outlet generally aren’t profitable and lack the customer footfall in the initial days of operation. Also, comparable sales growth shows how much the company’s revenue from its existing store network is growing. So, keep an eye out on this metric.
- Store Additions – As mentioned above, restaurants grow their revenues by opening new stores. So, it’s vitally important to track their pace of new store additions as well. Generally, an increase in the number of stores/outlets indicates growth and is a positive sign for the company and its investors, since this increases future revenue potential for the company. It also signifies the company’s management and its board’s confidence in the restaurant chain and how it’s being operated. A restaurant chain that’s struggling to maintain its revenue base, or maintain customer footfall levels, is likely to be embroiled in fixing their comparable sales and investing in improving its customer experience. However, restaurant companies generally engage in store expansions only when they’ve found success with their existing store network and are looking to recreate with new store openings.
- Average weekly sales– Average weekly sales, also called average weekly net sales , refers to the average revenue a company generates in an operating week. This item is an excellent and simple basis of comparison between companies in this industry. Higher AWS signifies increased sales volume and customer footfalls.
- Revenue per average customer/average sales transaction– Similar to average weekly sales, the average sales transaction refers to the average revenue per transaction. High average sales transactions can imply that the customer footfalls aren’t huge, but customers spend a lot more per transaction on average. This is generally true for high-end luxury restaurants. Low average sales transaction may imply a wider reach to the customers and greater footfalls, but at a low-price range of menu items sold — food chains and drive-throughs generally come under this category. Average unit volume (AUV) is a similar metric that refers to the average revenue per open unit or studio of the company.
- Revenue per employee– Revenue per employee is obtained by dividing the revenue of the company by the number of its employees. Just like average weekly sales, average sales transaction, and average unit volume, this metric is fairly straightforward. It shows the amount of revenue the company is generating per employee. Revenue per employee generally indicates the efficiency of the company. A sudden spike in the revenue per employee may indicate that the company has let go of significant employees, whereas a sudden fall in this measure may indicate alternative problems like excess personnel or a fall in revenues.
- Franchised restaurants percentage– The division of branded restaurants into self-owned outlets and franchises, is important. It signifies the company’s revenue-generating capability by way of direct sales to consumers, as opposed to earning royalties and franchise fees from franchised stores. An increase in the franchisees of the company may indicate that people and investors deem it profitable, successful and investable, hence more people are willing to run a business under the brand name. Franchise fees and royalties are a stable source of income for the restaurant chain, with minimal operating costs or capital expenditures involved.
- Day-part sales mix %– Day-part sales mix is the segregation of revenues based on the time of day it is incurred. In other words, it allocates what percentage of revenue is incurred during a particular time of day. This metric helps restaurants understand the time of day that is busiest and lightest for them. It helps the company allocate resources better, and it helps the investors and other stakeholders keep track of such trends. For instance, if a company has been generating an average of 40% revenues during the afternoon time of day for a long time, but reports a sudden fall and reports the same item to be 15% in the latest period of reporting, it is possible that an unusual event has occurred, or the company has undergone a major change.
- Table turnover rate– Table turnover rate or table turn rate, is the average number of parties served per table. A higher turn rate can imply that the restaurant is serving more customers per table, hence maximizing its revenue per table. For companies with tight margins, the table turn rate should be more. It is calculated by dividing the number of groups served by the total number of tables.
- Revenue per available seat hour– As the name suggests, it refers to the revenue as a multiple of the available seat hours. A restaurant may maximize its table turnover by opening for longer working hours. This metric normalizes this practice and provides an accurate picture of revenue per working hour.
- Other obligations– Companies often enter into contracts and agreements which may force them to operate in a certain way, that might not be desirable in the short run. Such contractual agreements must be kept in mind before you decide to invest in a company.
Online ordering has increased over the years. With the consequences related to the Covid-19 pandemic, this rate has increased rapidly. There is greater demand for home-delivered food, and people are switching from in-restaurant dining at an increasing pace. People have also started to choose health over taste. There is a rising demand for healthy and organic food options and unhealthy processed foods are losing widespread appeal. People also prefer restaurants that are eco-friendly as they consider it a step towards a healthier environment.
Another trend observed in this sector is the growing use of technology and innovation in and outside the kitchen. All-in-one restaurant management platforms have now become an integral part of restaurant operators, and have proved important in terms of better product management, customer satisfaction, and service optimization. Companies like Starbucks doubled their unique customers within 2 years of their app launch.
Why Invest in Restaurant Stocks?
The restaurant industry is one of the fastest-growing industries currently. As time is progressing, more people are eating out and contributing to this. Many companies like Chipotle Mexican Grill have announced that a significant number of restaurants that it opens this year will have drive-thru facilities. Since the pandemic is not going anywhere anytime soon, restaurants are adapting themselves to the new normal. Such drive-through and takeaway options will also encourage those people to eat out who would otherwise not prefer dining inside a restaurant. If you look at the stock prices of a few companies like Blooming Brands and BJs Restaurants, it is visible that they have not completely bounced back to their prices pre-pandemic, which makes it a good time to buy these stocks.
Here’s a list of restaurant stocks listed in the US as of February 18, 2021, ranked by their market capitalization:
|Stock||Market Capitalization||Price to Sales (TTM)|
Risks of Investing in Restaurant Stocks
- 99% of companies are not listed– The majority of the restaurants in this industry are not listed on the exchange. A major portion of the restaurant sector is owned by private companies or individuals, which makes it less regulated compared to other sectors like oil and gas. Tracking this sector is also difficult because of this reason.
- Difficulty in Profitability – Restaurants business is capital intensive in nature. From pre-opening costs down to their day-to-day activities, there are various kinds of capital expenditures and depreciation expenses involves. All these expenses can quickly rack up and weigh on their margins. Many newcomers and restaurant startups are unable to sustain the cost margin model in this industry and companies, generally, have to remain operational to break even and take advantage of unit economics.
- Shift to Health foods – There is the growing trend of eating healthy nowadays, which is weighing on fast-food and traditional restaurant sales. This heightened impetus on healthy foods has already put many companies to bed and given rise to new companies that are either unreasonably expensive or are not sustainable in the long run. So, make sure that the restaurant stock you’re picking, isn’t catering to a niche and sitting well with the health-conscious consumers.
- Future Uncertainty – As mentioned earlier, restaurants can take a considerable amount of time to become profitable and take even longer before they can earn decent returns for the stakeholders. In the early stages of a startup restaurant chain, it may be difficult to decipher and predict whether the concerned company would close shop in a few years or would go on to become a successful story.
- Other concerns – Many companies like fast food chains enter into agreements that compel them to fulfill certain obligations, such as opening a certain number of outlets and/or franchises within a stipulated time. Contractual obligations of such a face may make the stock price volatile as they may constrain the company to take actions, which might not be in the best interest of its shareholders.
The interesting part about restaurant industry is, only 1% of the restaurants are listed on stock exchanges! Companies like McDonald’s, Burger King, Starbucks, Blooming Brands, and other listed companies may not be a true depiction of the industry and are those companies that have gained enough public trust to have received IPO subscriptions in the first place. Since then, they have grown and shaped to fit and fulfill the expectations of their consumers and other stakeholders and gained an advantage pertaining to public support. All the key metrics discussed above are a few of the parameters that should be considered while looking at a restaurant operator, subject to the limitations of this industry. Associated trends give us an idea of how this industry will look like in the near future, and which companies the investors should target to be in line with these trends.
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